Top brass at Nortel found not guilty as Judge dismisses charges against ex-CEO Frank Dunn, ex-CFO Douglas Beatty and ex-controller Michael Gollogly

TORONTO — Ontario Superior Court Judge Frank Marrocco ruled Monday that Nortel’s top three financial executives — Frank Dunn, Douglas Beatty and Michael Gollogly — are not guilty of fraud affecting public markets. The sweeping verdict was delivered before a packed courtroom along Toronto’s University Avenue, 364 days after the start of the trial and nearly nine years after the RCMP began its investigation into Nortel’s accounting.

The three men, visibly relieved at the ruling, were each facing up to 14 years in prison. Little more than four years ago, they briefly shared a cell in a Newmarket detention facility. Each had been charged with seven counts of accounting fraud, later reduced to two. But, after hearing evidence from 17 Crown witness during a nine-month long criminal trial, judge Marrocco concluded the charges were baseless.

The accused can’t put everything behind them just yet. The Crown has 30 days in which to appeal the verdict. Dunn, Beatty and Gollogly also face a series of civil litigations that have on hold until the criminal proceedings wrap up. The most important of these are civil fraud charges laid in 2007 by the U.S. Securities & Exchange Commission. The three former executives have also been waging suits of their own — including one against Nortel for wrongful dismissal.

The not guilty verdict is another blow for both the Crown and the RCMP unit that launched the investigation into Nortel’s accounting in 2004. The Integrated Market Enforcement Team was formed in 2003 to send a message to fraudsters everywhere in Canada. In a show of resolve, the RCMP announced on the same day in June 2008 that it had laid fraud charges against the three Nortel executives as well as against six executives at Royal Group Technologies.

IMET has now lost both cases in rather convincing fashion. On the surface the Royal Group case looked to be the easier of the two legal fights. The RCMP alleged several of the firm’s senior executives, including CEO Vic De Zen, improperly secured a $6.9-million profit when they sold a parcel of land to Royal Group’s real estate arm.

Following a six-month trial in 2010, Ontario Superior Court Justice Richard Blouin ruled the transaction was proper, adding that there had been no attempt to conceal the transaction from company directors or auditors. Blouin acquitted the executives of fraud weeks before handing down his written decision.

Perhaps the most surprising aspect of the Nortel trial is that the Crown decided to prosecute Dunn, Beatty and Gollogly despite the lack of hard evidence. The RCMP spent four years preparing the case before laying charges in 2008. Crown prosecutors devoted another four years in an attempt to get the case ready for trial. Yet, in the end, lead prosecutor Robert Hubbard failed to produce a single email — of hundreds of thousands examined — in which the accused asked anyone to do anything wrong. Instead, Hubbard offered only a theory of how a crime might have occurred.

The essence of the Crown’s case was that Nortel’s top executives deliberately over-stocked the firm’s balance sheet with liabilities — which were later manipulated to create desired earnings in the fourth quarter of 2002 and the first half of 2003. This was done, the Crown alleged, in order to activate millions of dollars in executive bonuses.

However, the Crown produced no evidence challenging how and why Nortel put liabilities on its balance sheet. Nor was the Crown convincing when it alleged that Nortel’s accountants bent the rules when they removed liabilities to manipulate earnings. Crown prosecutor Robert Hubbard asserted that proof of the fraud lay in the fact that Nortel was forced to re-state its numbers a second time in 2005. But Marrocco considered a raft of documents showing that the re-stated numbers reflected differences of opinion and judgment about how to apply the relevant accounting standards.

Indeed, it was the defence that provided the lion’s share of evidence — and this showed that Nortel’s auditors, Deloitte, signed off on all the accounting entries the Crown alleged were done fraudulently. The real weakness of the Crown’s case was its failure to address motive and its apparent lack of understanding about how a large multinational conducts its business.

Hubbard took it as given that Nortel’s top executives would risk their reputations and careers for the sake of bonuses that would have been awarded at some point during 2003 — such was the strength of Nortel’s recovery from the telecom crash. Hubbard produced a 2003 letter drafted by Gollogly, in which the controller expressed qualms about accepting a bonus based on earnings that contained sizable entries that had little to do with company operations. But the letter, which was never sent, clearly expresses Gollogly’s concern over the spirit of the return-to-profitability bonus plan, not its legality.

The Crown believed from the beginning that it could win the case, not least because the foundations had been prepared by the company itself. Nortel’s board of directors fired Dunn, Beatty and Gollogly ‘for cause’ on April 27, 2004, thus triggering a series of investigations by the SEC, RCMP, the U.S. Justice Department and the Ontario Securities Commission.

All took their cue from Wilmer Cutler Pickering Hale LP, the Washington law firm Nortel hired late in 2003 to provide a second opinion on Nortel’s accounting. This was the spark for the flame that eventually engulfed Nortel.

Wilmer Cutler’s investigators were invited into Nortel’s inner sanctum, not because the board had concluded the firm’s accounting was illicit. It had done so because Nortel’s finance team had made mistakes during the crush of a savage restructuring in which two of every three employees — including company accountants — had been let go.

Attention may now turn to why Nortel’s directors failed to make a harder assessment of the allegations it received from Wilmer Cutler.

As for the criminal trial, it was up to the Crown to prove the allegations made by Wilmer Cutler. Marrocco ruled it failed to meet its burden.

An Ontario Superior Court Judge has ruled that Nortel’s top three financial executives — Frank Dunn, Douglas Beatty and Michael Gollogly — are not guilty of fraud affecting public markets. The verdict comes nearly nine years after the RCMP began its investigation into Nortel’s accounting.